Legacy Wealth Weekly - Oct 28, 2016 (A Feeling of Uneasiness)

Penni Johnston-gill - Oct 28, 2016

Despite cash levels in US equity mutual funds at 15-year highs and bullish sentiment on equities in the low 20s, stocks just cannot get any traction and remain unfazed by a relatively upbeat earnings season so far. For the week, Canadian and US stock

Weekly Market Wrap-Up: A Feeling of Uneasiness

Despite cash levels in US equity mutual funds at 15-year highs and bullish sentiment on equities in the low 20s, stocks just cannot get any traction and remain unfazed by a relatively upbeat earnings season so far. For the week, Canadian and US stocks are flat and the latter remain stuck in a three-month-old trading range. What gives? Obviously, hesitation about the US election outcome is among reasons. However, more central banks talking about reining in hyper monetary policy accommodation has caused turbulence in fixed income markets, pushing global bond yields to multi-week highs. US 10-year Treasury bond yields at 1.85% have comfortably pushed above their 200-dma (1.72%) and seem headed to 2% resistance. Again this week, the US$ has pushed higher without causing much of a pullback in commodity prices and EM currencies. As we explained in our Mid-Week note, we believe this bullish divergence originates from improving EM economic fundamentals.

Our focus this week is on US equities and what could explain investor hesitancy. One key issue is a history showing that when EM equities outperformed markets as they have this year, the S&P 500 usually lagged world equities. At this point, it is difficult to see a reversal, considering rising EM LEIs and the relatively attractive valuation of EM bourses (12.4x forward PE) vs. the S&P 500 (16.5x). Another key issue is the US$ surge and the widening credit spreads which have tightened financial conditions and pushed our proxy below last summer’s support. As our Chart of the Week shows, similar breakdowns in July and November 2015 preceded sharp corrections in US equities. As such, we recommend that investors stay neutral equities and continue to take risk exposure through the cyclical areas of the market. While the latter group could be more vulnerable if markets experience a correction, they should be the first to rebound due to a likely global growth re-acceleration in 2017/2018.

Regarding economic statistics this week, Belgium finally ratified the trade agreement between Canada and Europe. This comes as good news considering that non-energy Canadian exports are not growing as fast as the BoC would like them to. Otherwise, the budget deficit exploded to C$2.7B in August, a potentially bearish signal for the CDN$. In the US, durable goods orders fell 0.1% MoM in September and non-defense capital goods orders excluding aircraft, a good proxy for business spending, declined 1.2% (vs. 0.9% exp.). However, we learned this morning that US GDP growth settled at 2.9% QoQ in Q3/16 (from 1.4%), an argument in favour of a Fed rate hike in December. In addition, new home sales bounced back 3.1% MoM last month (from -7.6%), now up 29.7% YoY. In Europe, flash mfg. and service PMIs improved to 53.3 (from 52.6) and 53.5 (from 52.2) respectively. In Germany, the IFO business climate index increased to 110.5 (from 109.5), while in Italy industrial orders jumped 10.2% MoM in August. In all, low interest rates and a weaker Euro seem to be filtering through the economy, helping exports notably. Elsewhere, in Japan, the flash mfg. PMI (51.7 from 50.4), exports (-6.9% YoY from -9.6%), imports (-16.3% from -17.3%) and household spending (-2.1% YoY from -4.6%) all improved sequentially. Meanwhile, headline inflation exited deflation territory (+0.1% YoY from -0.5%) but the core reading remains anemic (-0.4% YoY) according to advanced October metrics (Tokyo CPI).

Next week, employment statistics (US and Canada), the Fed, the BoE and the BoJ are on deck. Also, aside from global PMI releases, we will focus on the trade balance in Canada, US PCE inflation, Q3/16 GDP growth and inflation in Europe, and retail sales and industrial production in Japan

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.